7 Reasons Bank Stocks May Keep Falling

Robert Barone|Guest Contributor

Tuesday, 18 Oct 2011 | 2:06 PM ETThe Street

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It appears that several factors are still not priced into the market. Continued downward pressure on financial stocks could be expected as events unfold, especially the potentially disruptive forces that Europe may unleash, or the conclusion that the foreclosure and mortgage lawsuits are larger and more significant than currently believed.

Here are the top seven reasons bank stocks may keep falling.

Occupy Wall Street

Although it's not a cohesive movement, at least part of its birth can be traced to outsized Wall Street salaries and bonuses, especially since taxpayers saved most of the "Too Big to Fail" (TBTF) banks.

Bank Transfer Day, Nov. 5, is when Americans are supposed to transfer their deposits to community banks. It’s more symbolic than real, as the TBTF banks' core consumer deposits are only a small portion of their liabilities and can easily be replaced with no-cost or low-cost funding from the Federal Reserve or elsewhere.

Nevertheless, Bank Transfer Day is a public relations issue for the large banks.

Margin Squeeze

Big banks have used the arbitragespread between borrowing costs (near zero) and Treasury yields(2 percent+) to profit.

Also, the purchase of Treasury securities requires no capital under the capital regulations, as Treasurys are "risk free." The Fed's new policy of Operation Twist targets longer-term interest rates and squeezes this arbitrage spread.

The Volcker Rule

This has recently been put out for comment by the FDIC.

It severely limits trading profits made for the TBTF banks' own accounts and is likely to have a big impact on big banks' trading profits going forward.

Debit Card Monthly Fees

Although such fees are a direct consequence of the limitation on debit swipe fees by the Fed under Dodd-Frank, and while it was common knowledge that the big banks would find a way to increase fees elsewhere to make up for their losses on the swipe fees, the timing has turned out to be lousy, and the big banks are taking a public relations hit — even from the sponsors of Dodd-Frank, who clearly knew there would be unintended consequences.

European Bank Exposure

U.S. financial institutions have $641 billion in direct exposure to banks in the fiscally troubled European PIIGS nations — Portugal, Ireland, Italy, Greece, and Spain — according to an estimate last month by the Congressional Research Service.

So a freezing up of liquidity flows to those institutions may have an impact on the value of such holdings.

It is clear the Fed and the European Central Bank will intervene with massive liquidity injections if such events unfold. Nevertheless, the risk of such a freeze-up exists. Further, if contagion spreads because of a Greek default, it is likely that the shares of the big banks will be negatively impacted.

So far, we have seen the equity prices of these behemoths ebb and flow with the news (or hopes) out of Europe regarding their evolving "rescue" plan.

Mortgages and Foreclosures

Foreclosures at the TBTF institutions are rising because moratoriums have expired and "robo" issues have been addressed.

In addition, so-called prime loans in portfolios (usually "jumbo" loans — those that are larger than the Fannie Mae limits) are becoming a big issue as there is a clear trend toward rising "strategic" foreclosures.

In fact, Fitch recently downgraded many of these "prime" mortgage pools.

This calls into question the quality of what may be on the TBTF balance sheets in the form of such jumbo loans. The fact that Fannie Mae and Freddie Mac reduced their loan maximums on Oct. 1 is destined to have a huge negative impact in states like California and Florida, where the prices of higher-end properties will fall due to the unavailability of financing.

So expect "strategic" defaults to rise rapidly in these states.

Lawsuits

Half of America's mortgages are on the Mortgage Electronic Registration System, but in many states MERS has no standing in foreclosure.

Theoretically, every owner of a securitized pool should sign off on each foreclosure in the pool. There could be hundreds, if not thousands, of owners in these pools.

In addition, many jurisdictions require that title transfers be recorded in county recorder offices. Since that did not occur, lawsuits are now being developed against the major TBTF players for lost recording/title transfer fees.

The Dallas district attorney recently sued MERS and Bank of America for $100 million of such fees.

According to Mark Hanson, since MERS has been operating since 1995, there could be billions of dollars of such thwarted fees. Because nearly every local governmental entity is hungry for funds, this could catch on like wildfire.

Bank of America's $8.6 billion global services settlement is in trouble, as Attorney General Eric Schneiderman says it should be closer to $25 billion,. He is getting support from other states, including California.

The rumor mill has circulated the theory that if lawsuit settlements become outsized, Bank of America appears to have the option of bankrupting the old Countrywide unit, which it has kept as a separate legal entity since its purchase in 2008.

Imagine, though, the market reaction to such a move! Lawsuits on mortgage trustees are just starting.

According to Bloomberg, U.S. Bancorp , Bank of New York Mellon , Deutsche Bank , Wells Fargo , HSBC , Bank of America and Citigroup are the major mortgage trustees.

Bloomberg speculates that since these institutions didn't underwrite, sell, securitize, service or ship loans according to regulations, the odds are low that the trust departments got it right.

So far, Schneiderman has requested documents from Deutsche Bank and Bank of New York Mellon.

In early September, the Federal Housing Finance Agency, the receiver for Fannie Mae and Freddie Mac, sued Bank of America, Citigroup, JPMorgan Chase , Barclays, HSBC , Credit Suisse , and Nomura Holdings demanding refunds from these institutions for loans sold to Fannie and Freddie that were based on false or missing information about the borrowers or the properties.

The FHFA said the two mortgage giants purchased $6 billion from Bank of America, $24.8 billion from Merrill Lynch, which is now owned by Bank of America, and $3.5 billion from Citigroup.

Lawsuits and foreclosure issues are making the TBTF banks sorry they are in the mortgage business.

JPMorgan's Dimon announced the company is going to be leaving the mortgage business, and Bank of America said that by year's end it will stop buying mortgages from correspondents.